Tuesday, April 01, 2008

The Picture

Commodities are generally selling off. Gold has now lost a solid 10% from its high.

ISM Manufacturing came in low, but slightly better than the previous month. Very consistent with yesterday's Chicago PMI. The employment index increased. Costs are still rising rapidly and some industries are seeing solid export growth. Construction spending was lower on the month, but better than projected. Growth in manufacturing spending continues, although power construction is off YoY now.

The probable reason that commodities are selling off is that the next round of credit losses is now being recognized, and this round is not US-centered. Just as Northern Rock went bust all on its own - making risky mortgages to UK buyers, the big weakness in Europe is mortgages in some bubble areas and very, very dicey commercial lending, including high yield debt to businesses and commercial mortgages. There is also extreme weakness hiding in some private equity ventures, many of whom have loans with banks. The first wave of recognition is just beginning.

It is somewhat amusing that stock prices on financials are tending to rise on this news. It won't last. The two biggest reporters were UBS and Deutsche Bank. Many more will follow.

Anyway, commodity pricing was part currency hedging, part fundamental demand and part speculation. The fundamental demand piece is weak due to generally lower growth projections, the speculators are tending to sell off, and the dollar weakness will now be met by pressures on other currencies.

Another round of burblings from ECB has been emitted. They are trying to lure national governments to stand firm on labor contract negotiations with the carrot of a rate cut. But this is quite impossible due to high food and fuel inflation in Europe, which is transmitting through into wage demands and weakness in retail spending.

``Our risk scenario of a consumer recession in Germany is getting more and more likely,'' said Andreas Rees, an economist at UniCredit Markets & Investment Banking in Munich. ``Further increases in costs for food and energy'' will ``dent purchasing power in the months ahead.''

The property booms in Europe are mostly slack or declining. The hardest hit economies like Spain and Italy may be forced into deficit spending.

Some of the EEMs are still doing well, but some are in difficult straits. We will continue to see rising defaults on all types of debt - consumer, residential, commercial mortgages and commercial lending in some of these market areas. Just as in the US, companies which primarily sell to consumers are experiencing pressure.

The situation for Asia is now quite alarming. It relates to the rise in basic consumer commodities such as food and fuel. Many of these countries subsidize those purchases for their people, or at least for their lower-income people. This of course has tended to suppress wage costs, but it causes a severe problem for the governments when those costs increase and increase government spending.

Back in the late 1990s, there was something known as the Asian currency crisis. Here's a Wikipedia primer:

The East Asian Financial Crisis was a period of financial crisis that gripped much of Asia beginning in the summer of (July) 1997 and raised fears of a worldwide economic meltdown (financial contagion). It is also commonly referred to as the East Asian currency crisis or locally as the IMF crisis.

The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven.[neutrality disputed] At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. The drastically reduced import earnings that resulted from the forced devaluation then made a quick or even medium-term recovery impossible without necessary international intervention. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and asset prices, and a precipitous rise in private debt.[1]

Though there has been general agreement on the existence of a crisis and its consequences, what is less clear were the causes of the crisis, as well as its scope and resolution. Indonesia, South Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also fairly hurt by the slump. Mainland China, India, Taiwan, Singapore and Vietnam were relatively unaffected. Japan was not much affected by the crisis but was going through its own long-term economic difficulties. However, all of these Asian countries saw their currencies fall significantly relative to the United States dollar, though the harder hit nations saw extended currency losses.

The same basic parameters hold today.

As inflation on basic needs rises, the ability of the poorer consumers of the world to buy stuff like DVD recorders and even extra clothing collapses. We have probable overcapacity in production in Asia on consumer electronics and pharmaceuticals plus shoes and clothing. Marginal producers will take hits.

In Asia the expected effects are first damages to the balance of payments in the less developed economies and collapse of commercial real estate and property bubbles. The second round effect goes to the more developed economies (such as Japan) that sell equipment for manufacturing to these countries.

The net effect is a constraint in the interAsian trade.

The Political Consequences:In the 1990s the IMF moved in and got more developed countries to support the currencies of the countries most affected. In exchange it demanded that the governments change some of their policies in ways that inflicted great pain upon the populations involved. This appears to have been the primary fuel for various nationalistic movements extremely hostile to the West in countries from Indonesia to Turkey. The rise of Islamic fundamentalist movements demanding world dominion and the like is almost certainly more related to world economic events than imams.

Carbon Tariffs:Imposing carbon tariffs will greatly exaggerate the pain to many of the Asian countries. It would cause additional constraint in world trade, which will reinforce the overcapacity and trade imbalance problems. It will provide fodder for extremist Muslims in Indonesia and will serve to reinforce the IMF lesson. I'm not kidding about world war.

The misunderstanding about inflation is this: Recent low inflation in the world was caused by exporting labor costs to cheaper areas. This was efficient, but in effect it moved labor demands to low-cost economies. Many of those economies subsidize basic consumer commodities such as grains and oils, and often fuel. The rise in exports helped to pay for those subsidies.

However this has left world labor costs acutely sensitive to rises in basic commodities. As soon as those rise (and they have, and the rise continues), the entire world will see an inflationary impact. Costs to countries which subsidize consumer necessities rise far more than marginal taxation can comfortably pay for. (The average highly developed bloc consumer expenditure for food is around 20%. In the EMs it can easily be 50%.) The alternative for those countries is to tack on export taxes to control any costs they can, plus generate more money for internal subsidies, or to cut subsidies. Needless to say this stimulates another round of inflation for the basics.

We have now reached the point where rice-exporting countries are cutting back on exports one way or another. That is the point at which one must take this seriously indeed.

The result is that the more developed countries which exported production will get inflation squared back. However, their generally wealthier population can continue to pay the base costs far longer than the populations of the less-developed third of the world, but consumer discretionary spending will be cut to some extent. This cuts inflows to the economies which are experiencing the most pain, and generally exacerbates labor, political and financial troubles. The effect is hard to control. Eventually it shows up in currencies in one way or another.

The fix for the trade imbalance is for the Asian countries to stimulate domestic demand, but obviously this will generally fail when basic commodity costs rise sharply. Either labor costs rise, or corporate taxation rises, or export taxes rise. The cost of exported goods must jack up sharply.

Trying to control this type of inflation by controlling internal domestic monetary policy is bizarre. I do not see what the EU is trying to do. Its policy makes no sense.

Living standards in the EU and the US have to adjust downwards because the imbalance in trade is not sustainable. Letting the inevitable happen is the graceful thing to do, and as the adjustments proceed the imbalance begins to work itself out, the more developed economies become more competitive, and slowly that redistributes inflationary pressures.

Handling economies is like driving. You need to look not right in front of the wheels but far down the road. If you focus on the road right in front of your vehicle, you will tend to overadjust and swerve erratically down the road, causing other drivers to curse and dodge. Slapping on a carbon tax is so extremely shortsighted a venture that it boggles the imagination.

Commodities are generally selling off. Gold has now lost a solid 10% from its high.

So much for all the "Hal Lindsay of Gold Futures" blogs and websites and Art Bell phone-in ads, i.e. "TOTAL GLOBAL ECONOMIC COLLAPSE! SECOND GREAT DEPRESSION! WHEELBARROWS OF WORTHLESS GOVERNMENT FIAT PAPER! IT'S ALL OVER BUT THE SCREAMING! GOLD! GOLD! GOLD! GOLD! GOLD! GOLD! GOLD! GOLD! GOLD! GOLD!..."

Were you all aware of Soros massive currencyspeculative trading brought those emerging Asian country(ies) to their knees? Concluded at the time that internat. currencytrading, amounts, and duration of holding must be highly restrictive to protect a country's banking system, economy, etc.

At the moment, have forgotten exactly what the foreign ministers stated would do to Soros-- real world-- for such dire effects. 'First, Kill all the lawyers', was tame in comparison.

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Society has to tax the polluters & oil profiteers and hand over that tax revenue for viable (what then be public--private ) startups for any progress to take place at all.

And, the more developed countries have to giveup some of their greedy, gluttonous, war-driven ways of operating.

Some do manage to be smug and poor, in a "I'm holier (or greener) than thou" sense.

In my industry the downturn is behaving a bit oddly; seeing less domestic demand than normal (only seeing small projects). I'm wondering whether the companies are playing a waiting game, or whether they just can't find credit at affordable rates ...

John, I'm guessing it's an inflationary squeeze. Things are quite competitive and all the PPI and CPI reports show that cost increases start high and get cut at each stage. One can do that for only so long.

SI - yes. LTCM. A lot of those countries have those firewalls, but they have problems of their own.

As for the Mexican bonds, that was another bank bailout. Congress wouldn't so Clinton did. The Clintons were always in bed with the bankers. And commodities traders. I figure Hillary realized how darned easy it was to make money....

The busting carry trades have a lot to do with currency moves right now.

Ah, yes, LTCM genuises and their greedy investors in that Fund Debacle which almost brought the western+ financial systems down completely.Plunge Protection Team over another weekendstaved it off for a while. Read some of those genuises asses were back in the game of Hedge Funds again this round.

Rubin was behind that U.S. taxpayer funded Mexican bailout --for HIS FIRM's VESTED INTERESTS. Forgot how much his firm had to loseon those bonds and currency manipulations--by his firm. These guys are all from the same tribe too. That's factual.

Oil has been above $50 for quite awhile now which impacts Ag prices given the low per capita income of China/India i.e.$3500. this quickly shows up in the monthly food cost. The conflict between using AG products for fuel production or food is also a major issue here but lines the ability to produce food cheaply for the growing world population given the cost of energy looks doubtful.

this bit from a good website that tracks Pension related issues and had a post this morning regarding CRE, given MOM discussion about gov't spending I thought this on topic.I have also provided a link to the site.

"Kevin Thorpe, vice president of research at Cassidy & Pinkard, said the vacancy rate in the District could reach 11.9 percent in 2010, making it the "highest since the S&L crisis of the early 1990s."

The Washington region, unlike other places, is expected to add between 20,000 and 25,000 jobs this year, which will create a demand for office space.

"You've got $8.6 trillion that has been pledged to address this financial crisis and that's going to require significant oversight in the D.C. region," Thorpe said. "That has to translate to job growth and a demand for office space among law firms, accountants, consultants and others. Over time, demand will increase."

For landlords, weakness elsewhere in the private sector is creating a new "love of government tenants," said Keith Lipton, executive vice president and managing director of Grubb & Ellis's Washington-area offices. "They're the best tenant you're going to find. People who shied away from government tenants are now pursuing them. They are the strongest, most stable tenant out there."